Efficient Markets Theory and Behavioral Finance

EFFICIENT MARKETS THEORY AND BEHAVIOURAL FINANCE Name Affiliation Lecturer Date Introduction Efficient market theory is a theory used in investment that upholds the argument that the market cannot be beaten easily as the efficiency in the market causes existing stock prices to utilize and reflect all useful information…

Introduction

In this theory, therefore, assumptions are done perpetuating that the information organisation and the behaviour of market participants systematically control individuals’ decisions in investment and the outcomes of the market. According to (Malkiel, 2003) the efficient market theory, has implications of theoretical perspectives to the market trends, while it ignores or under estimate the practical perception of the market. On the other hand, the behavioural finance theory has been thought of being more practical based and focused on people’s behaviour (Ashta & Patil, 2007). Following the event of the financial crises in 2007 to 2010, contention has developed amongst various authors on its implication to popularity of the already criticised efficient markets theory and its contribution to the upsurge of the prevailing interest in behavioural finance theory. This paper compares and contrasts the explanations of efficient market theory and behavioural finance with regard to the financial crisis 2007 to 2010 and identifies the explanation considered to be strongest. Efficient market theory versus behavioural finance theory and the 2007 to 2010 financial crisis The efficient market theory upholds the notion about the randomness in stock prices, based on short-run serial relationships amid successive changes in stock prices (Malkiel, 2003). ...

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